U.S. Tax Enforcers React to The Panama Papers

The release of the ‘Panama Papers’ by the International Consortium of Investigative Journalists (ICIJ) has brought even greater attention to the use of ‘offshore’ entities in ‘tax havens’ to hide assets. While there initially appeared to be little US nexus to the clients of the Mossack Fonseca firm because of its publicly stated policy of avoiding American clients, the massive data release on 9 May 2016, produces thousands of hits for the ‘United States’ for entities, intermediaries and individuals. So American responses have been underway, and more will be forthcoming.

The Panama Papers leak raises important questions of financial privacy and the extent to which unlawful computer hacking can damage the lives of thousands of people who may be in compliance with the law. From an enforcement perspective, however, the ICIJ disclosure will supplement the already substantial investigative actions undertaken in the US and provide authorities with new leads to Americans hiding assets in offshore companies. It has already prompted American regulatory action to counter the impression that the US has lagged behind other countries in pursuing financial transparency. This article will review the implications of the Panama Papers data on these continuing US enforcement and regulatory efforts.

The Enforcement Rubric Acquires More Data

In the eight years since the UBS controversy began, the US government has aggressively pursued American taxpayers (residing both in and outside the US) who use offshore accounts and entities to hide assets from the Internal Revenue Service (IRS). In doing so, American prosecutors and investigators have largely broken bank secrecy on a global basis.

The US Department of Justice Tax Division (DOJ) continues to conduct criminal investigations of account holders, financial institutions and third party enablers or facilitators of US criminal tax evasion. Since early 2009, the DOJ has prosecuted, obtained indictments and convicted dozens of account holders hiding funds abroad. These individuals, and thousands of others, also have been subjected to aggressive civil tax examinations, with large penalties assessed by the IRS, sometimes multiples of the assets at issue. These enforcement efforts extend to banks, bankers, account managers, investment advisors, lawyers and others alleged to have enabled or conspired with American clients in their concealment of assets. A number of major banks remain under grand jury investigation.

The DOJ has also received submissions from 80 Swiss Banks that came forward through its Swiss Bank program to obtain non-prosecution agreements, providing a wealth of data. The DOJ is now analysing this data, using it to ‘connect the dots’ on US taxpayers’ activities abroad, and incorporating it into treaty requests on partner countries to learn the identities of American account holders. In late April, the IRS served yet another treaty request on Switzerland for banking details of Swiss HSBC clients, and we expect more to come.

The US also continues to use its legal processes to garner information worldwide. For any financial institution or other entity with a presence in the US, the government can serve IRS administrative summonses or grand jury subpoenas for information on noncompliant US taxpayers. Such demands for information can also reach the correspondent accounts of foreign banks held in the US. And the IRS has demonstrated it can successfully compel the production of the names of taxpayers whose tax liability it is trying to determine through the ‘John Doe’ summonses procedure. The IRS and DOJ have increasingly utilised the John Doe summonses to obtain correspondent banking information or even evidence of credit and debit card usage through firms that process such data.

More recently, the DOJ has returned to a tactic from the 1970s and 1980s, the so-called ‘Bank of Nova Scotia’ summons. Named after an important court case, this type of summons seeks to compel a bank’s US branch to produce records of a foreign branch, even if the foreign jurisdiction has bank secrecy. Earlier this year, the US issued such a summons to force UBS’s branch in Miami to deliver records of a Singapore account purportedly owned by a taxpayer who lives in China and is under IRS audit.

The ongoing ‘war’ on offshore accounts is enhanced further by various disclosures that voluntarily come into the IRS and DOJ. Whistleblowers provide the IRS with information and can receive significant rewards; previous media leaks, such as the ICIJ’s ‘offshore’ project, add to the data. The various IRS Offshore Voluntary Disclosure Programs also provide another dataset regarding offshore banking; IRS agents engage in follow up activity to these disclosures, mining the data provided and interviewing individuals who came forward to obtain more detailed information about others who facilitated their use of foreign accounts.

And the US is now receiving reams of data as a result of the Foreign Account Tax Compliance Act (FATCA), which requires foreign financial institutions to report information regarding US account holders with assets at their institutions. The US has entered into FATCA agreements with dozens of countries to facilitate such disclosures.

US tax enforcement and other officials are already pouring over the database released 9 May 2016. Public reports have revealed that the US Attorney’s Office for the Southern District of New York, known for its hardball prosecution strategies, is looking into the Panama Papers disclosures. Congressional investigators also appear to be gearing up. It remains to be seen whether this activity will produce a new round of indictments or other enforcement actions, or a new wave of voluntary disclosures like those that grew out of the UBS and related cases. We suspect that there will be cases that come out of the Panama Papers leak, but perhaps not in the same volume as those brought from 2008 through 2015. Having said that, leaks sometime ‘begat’ further disclosures, so this could cascade into yet more and more cases.

New Steps Toward More Global Enforcement

Apart from new enforcement actions, the most significant fallout from the Panama Papers is the increasing public focus on global financial transparency, and more specifically, the growing perception that the US allows for less transparency than it expects from other countries. International critics point to laws in states such as Delaware that permit LLCs to register without disclosing their beneficial ownership. Our FATCA counterparties complain that the US is imposing transparency standards on other countries but that the American Congress will not enact law to authorize the government to collect and disclose reciprocal information.

Perhaps attracting more attention has been the absence of US movement in the face of actions by OECD member countries and international organizations to combat financial secrecy through broad based automatic information exchange systems such as the Common Standard on Reporting and Due Diligence for Financial Account Information (CRS), and to authorise the exchange of greater information on beneficial ownership of entities. Further, the European Commission released a final proposed directive requiring multinational corporations to publish Country-by-Country (“CbC”) reports online with certain information required by action 13 of the OECD’s base erosion and profit-shifting project. The final directive added, as compared to the draft proposal, an additional requirement to report separate CbC data for countries that “do not respect international tax good governance standards,” effectively, creating a tax haven ‘blacklist’ of jurisdictions that are not compliant with international standards.

The US has been behind the curve on these initiatives, in part because it is a ‘federal’ system where state law governs corporate registrations, and in part because of Congressional gridlock. However, the Panama Papers has quickly accelerated an American regulatory response. In recent weeks, the US Treasury Department announced various actions to strengthen US financial transparency, and the Treasury Secretary, with the explicit endorsement of President Obama, recently sent a letter to Congress urging it to act on legislation that would allow the US to increase compliance with global transparency standards and to approve bilateral tax treaties currently pending in the Senate. New measures include:

The US Financial Crimes Enforcement Network’s (FinCEN) has finalized its ‘know your customer’ regulations, first proposed in 2014, requiring financial institutions to collect and verify the identity of any individual who owns 25 per cent or more of a legal entity, and an individual who controls the legal entity.

The Treasury Department issued new proposed regulations that would require foreign-owned single-member LLCs to obtain employer identification numbers (EINs) and to report its foreign owners and certain transactions to Treasury under section 6038A of the Internal Revenue Code. These regulations attempt to close loophole where in certain states foreigners can organise LLCs without disclosing beneficial ownership.

Treasury announced that it would propose legislation requiring US companies to file beneficial ownership information with the Treasury Department at the time of a company’s creation. Such legislation would enable the US to provide full reciprocity with FATCA partners.

The proposed legislation also clarified FinCEN’s authority to collect information under Geographic Targeting Orders (GTO). The most recent GTO, issued in January of 2016, temporarily requires US title insurance companies to identify and report the beneficial owners of LLCs that engage in all cash purchases of high-end real estate in New York and Miami. FinCEN indicated that it would evaluate the information obtained to determine whether the GTOs should be extended and/or expanded into a more comprehensive rulemaking.

One other element of the Panama Papers has begun to attract substantial attention – the implications for professional services firms throughout the world. Listed in the database released on 9 May 2016 are a number of highly reputable law firms and other service providers who helped in the formation of the offshore companies at issue. To be sure, it is likely that many thousands of the structures described in the Panama Papers are legally and properly reported to home country tax authorities. But many undoubtedly are not, and some of those unlawful structures may be in place without the knowledge of the professional advisors who helped set them up or who manage them.

With an increasing enforcement focus on enablers and ‘gatekeepers,’ the Panama disclosures thus have led some firms worldwide to look at their client intake and management procedures. It may behoove lawyers, accountants, fiduciaries, investments advisors and others to evaluate whether their clients’ ‘risk profiles’ are acceptable and to implement enhanced due diligence procedures for new business. No reputable professional in one country wants to aid or assist a client in violating the law, even if it is the law of another nation, and having an effective risk management and compliance program always helps an organisation even in the face of isolated, even unwittingly accepted, problem clients.

The Panama Papers disclosure, even if not ‘US-centric,’ nonetheless has and will continue to spur an American reaction. There will undoubtedly be new criminal cases and civil or regulatory actions. And while the US legislative process has heretofore slowed further reform, the publicity surrounding the Panama Papers may serve as an impetus for Congress to pass legislation and approve treaties that may have otherwise languished. As we have already seen, the US is beginning to step up its efforts, in a way that its European counterparts have already done, in promoting international financial transparency.